Top Tax Tips for Retirees

We spend a lot of time on our site helping and talking to many retirees, semi-retirees and Canadians preparing for their financial independence dreams. On that note, as the end of another calendar year approaches and with a new year ready to begin soon we thought we’d share a few of our top tax tips for retirees.

Read on for the goods!

Top Tax Tips for Retirees

Beyond talking about the weather, or inflation; beyond discussing Tim Hortons coffee or hockey – Canadians love to talk taxes. 

What’s more, Canadian retirees or soon-to-be retirees love to avoid taxes!

Rightly so.

We hope to avoid taxation in our retirement as well.

In Beat the Bank by author and former banker Larry Bates, (you can read more here from My Own Advisor’s interview with Larry), Larry highlighted some wealth-builders and wealth-killers:

Wealth builders:

1. Your savings rate and investing/contribution amounts.
2. Time invested.
3. Rate of return.

You and I have some direct control over a few of these wealth-builders. Essentially, the more money invested, the more time it remains invested, and the higher rate of return for your investments – the larger your retirement nest egg should be.

And for the record, dividends – don’t you know – are a HUGE part of stock market returns.

Source: RBC

Dividend-paying companies tend to represent a significant portion of the Canadian equity market and are typically well-established, soundly managed companies with stable business models.

So, dividends can provide Canadian retirees with both income today AND remain an important part of a portfolio’s total return, helping to offset losses in times of market declines, while boosting portfolio returns when markets are rising.

This means as part of wealth-building you must at least consider the compounding power that reinvesting dividends delivered from dividend paying stocks can deliver.

Further Reading is here: How to Automatically Reinvest Dividends.

Wealth killers:

Larry went on to write about retirement wealth-killers:

1. Money management fees
2. Inflation
3. Taxation.

Any one or more of these things are wealth destroyers.

You already know from reading our site that money management fees are forever – meaning the money you pay in fees to manage your investment portfolio is money you will never see again – so choose wisely when you consider how and by whom your money is managed.

If you haven’t already done so, consider building some or all of your portfolio with some low-cost Exchange Traded Funds (ETFs).

When it comes to minimizing taxation, we believe you should consider investing in the following order in your asset accumulation years, generally speaking:

1. TFSAs
2. RESPs – if you have kids (including taking advantage of the government grant)
3. RRSPs
4. Taxable accounts.

When it comes to minimizing taxation in your asset decumulation years, a long list of considerations comes to mind.

Here are our top tax tips for retirees, to help avoid and/or minimize the impact of wealth killers in retirement.

Top Tax Tips for Retirees – Asset decumulation

1. Keep assets in the right location

Generally, there are four types of investment income and each source is taxed differently:

• Canadian dividends
• Capital gains
• Foreign income
• Interest income.

Canadian dividends and capital gains are taxed more favourably. Canadian dividend income receives the dividend tax credit. At the tme of this post, only half of capital gains are subject to income tax. Interest income and foreign income, on the other hand, do not benefit from any preferential tax treatment and are fully taxable.

So, in keeping the tax treatment of these four types of investment income in mind, we believe if you are going to invest in a taxable account then consider investing for Canadian dividends and/or for capital gains.

This means in retirement, consider owning any Canadian equity holdings in your taxable account. On the flip side, you can then own other assets that earn interest income or foreign income in tax-sheltered accounts like your RRSP/RRIF or LIRA/LIF.

• Here is everything you need to know about the RRSP.
• What is a RRIF and how does a RRIF work?
• Learn more about LIRAs and LIFs in this comprehensive post for retirees.

Being tax efficient with your asset location not only has the potential of significantly reducing your annual tax liability but it can also deliver a healthy tax-efficient income stream throughout retirement.

We’ve seen this direction taken with many of our clients, and they are wealthier for it.

2. Get the tax credits available to you

Tax credits, without too much more mention, are natually helpful in reducing tax liabilities.

As 2022 ends and 2023 approaches, consider some of these common tax credits that might apply to you:

1. Pension income splitting – As a pensioner, you may be eligible to split up to 50% of your eligible pension income with your spouse or common-law partner to reduce the amount of income tax you may have to pay, if your spouse or common-law partner is in a lower tax bracket.
2. RRSP deduction – Deductible RRSP contributions can reduce your taxes owing. You can contribute to an RRSP up until the end of the year you turn 71. You can also contribute to your spouse’s or common-law partner’s RRSP until the end of the year they turn 71.
3. Medical expenses – You may be able to claim eligible medical expenses you or your spouse or common-law partner paid in any 12-month period.
4. Age amount – If you were 65 years of age or older, and your net income is below a specific threshold, you can claim up to thousands on your tax return.
5. Disability tax credit – If you have a severe and prolonged impairment in physical or mental functions, you may be eligible for the disability tax credit (DTC). If your spouse or common-law partner or your dependant has a severe and prolonged impairment in physical or mental functions, are able to claim the DTC, and they don’t need to claim all or part of the amount, they may be able to transfer the amount to you.
6. Pension income amount – You may be able to claim up to $2,000 if you reported eligible pension, superannuation, or annuity payments on your return.
7. Guaranteed income supplement (GIS) – The Guaranteed income supplement (GIS) provides a monthly non-taxable benefit to Old Age Security (OAS) pension recipients who have a low income and are living in Canada.

Check out how you can retire on a lower income with GIS here.

3. Split your pension income

Splitting pension income between spouses in retirement is another common way to reduce your household’s tax liability. With pension splitting, the higher-income spouse may transfer up to 50 per cent of their eligible pension income to the lower-income spouse. This reduces the household tax bill because the transferred income will be taxed at a lower rate in the lower-income spouse’s hands.

In fact, each individual can claim this amount for a total of $4,000 per year. The eligible pension depends on the type of income and/or the age of the pensioner. For example, Registered Pension Plan payments are considered ‘qualifying pension income’, regardless of the recipient’s age.

Both spouses must opt for pension income splitting on their tax forms. If both spouses have eligible pension income, only one can allocate funds to a spouse or partner in each tax year. Both must file a tax return that includes the elected split-pension amount.

What payments are eligible for pension splitting?

For those under age 65, the most common form of eligible income is from a registered company pension plan, whether defined benefit or defined contribution.  Individuals who are age 55+ can split pension income with their spouses.

Individuals without a registered pension plan can also take advantage of this tax strategy by converting their Registered Retirement Savings Plans (RRSPs) or deferred profit-sharing plans into income through a life annuity or a Registered Retirement Income Fund (RRIF). It’s important to note, however, that this income doesn’t qualify for splitting until after age 65.

If you are 65 years or older, eligible income includes:

• Registered Retirement Savings Plan (RRSP),
• Registered Retirement Income Fund (RRIF) or
• Deferred Profit Sharing Plan (DPSP).

What payments are not eligible for pension splitting?

• Canada Pension Plan (CPP) payments
• Québec Pension Plan (QPP) payments
• Old Age Security payments
• Earnings from a United States individual retirement account (IRA).

In terms of government pension sources, the Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) isn’t considered eligible income, although CPP/QPP benefits can be split based on a separate set of “sharing” rules.

What are the benefits of pension splitting/income sharing?

1. It reduces the taxpayers’ marginal tax rate. By transferring income, you decrease your net income and increase the income of a spouse/partner that has a lower income.
2. It reduces the OAS clawback.

Sharing CPP or QPP is available to spouses receiving these pensions but it’s important to note that CPP sharing is not the same as pension income splitting. The complete list of eligible pension income sources can be found on the Government of Canada website with a quick Google search.

4. Convert your RRSP to an RRIF before age 71

We have many clients in their 50s and 60s considering making withdrawals from their RRSP(s) before they turn age 71. We believe that can be very smart to “smooth out taxes”.

As someone approaching retirement or even considering retirement in your 60s, you should know that RRSPs must be closed/collapsed in the year an individual turns 71. It does not mean however you need to take RRIF income in that year.

To be tax-smart, avoid making major RRSP withdrawals in any given year or worse still, unless the RRSP value is very low, deregistering the entire RRSP amount in one year.

Instead, convert your RRSP to a RRIF and start taking your annual RRIF payments in the year you turn age 72, or ideally, for some, well before.

What we see often at Cashflows & Portfolios (when we do retirement income projections; in a low-cost way for Canadians), is the opportunity to convert RRSP assets to a RRIF income stream to help “smooth out taxes” for a few decades.

RRIF payments can be taxed annually at a lower marginal rate, so, the tax liability that is your RRSP nest egg is essentially spread out over time, avoiding major tax hits in any given year. This means, you should consider avoiding some conventional financial wisdom: always waiting until age 71 to convert your RRSP to a a RRIF.

If fact, based on pension income splitting information we shared above, if Canadians are age 65 or older and not receiving other pension income such as a workplace pension, then converting a portion, or all, of the RRSP to a RRIF early will allow retirees to take advantage of pension income splitting and withdraw money tax-free up to $2,000 per year.

For any diligent investor, with a large RRSP balance, mandatory age-related RRIF withdrawals can translate into larger taxable withdrawals and therefore increase taxation in your 70s and 80s when you least want that burden.

5. Consider your retirement income drawdown order carefully

Beyond the free posts, giveaways, and other free content on our site, we are happy to offer retirement projections for any Canadian at a low-cost. We’ll link to those services again later, below.

Aligned to #1 and keeping your assets in the right location, is the tax-savvy opportunity to draw down your assets in the right order to reduce taxation.

In a non-registered investment account, the great news is Canadian dividends, capital gains (and any return of capital) are taxed lower than interest income. However, this also means depending on any pension income, RRSP/RRIF assets, TFSA assets and other income streams in retirement, depleting the taxable account early in retirement could be the best account to draw down first (although not always)!

In order to maximize deferring taxes in retirement, a rule of thumb we help clients out with is withdrawals from the least tax-efficient accounts to the most tax-efficient sources – a “withdrawal order” if you will.

Here are some examples from least efficient to most efficient, depending on the clients’ assets and income sources:

• Investment income earned from investment holding companies, then
• Higher-income spouse/partner’s non-registered account, then
• Lower-income non-registered account, then
• LIFs, then
• RRSP/RRIFs, then
• TFSAs “near the end” for any estate planning or wealth transfer.

This withdrawal order is hardly a recipe but it does sometimes make sense to slowly withdraw from your taxable account(s) and/or RRSPs/RRIFs, early in retirement, to help “smooth out taxes” over a few decades as we have highlighted above.  The actual withdrawal order recipe would depend on your specific situation.

6. Make RRSP/RRIF withdrawals over time to fill up the TFSA!

The Tax-Free Savings Account (TFSA) contribution limit will increase to $6,500 (from $6,000) for 2023.

This new limit means that a taxpayer who has never contributed to a TFSA and has been eligible for one since its inception will have a cumulative contribution room of $88,000.

That’s a lot of tax-free compounding power.

Even if some retirees don’t need the money for spending, we see/discuss with some retirees an option to make some slow, methodical RRSP withdrawals in their 50s and 60s (i.e., to “smooth out taxes”) and move that money into their TFSAs to supercharge more wealth-building power.

Unfortunately, there’s no way to transfer money from an RRSP to a TFSA directly, without penalty.

So, consider this before you make this move:

1. Remember you’ll pay withholding taxes on the RRSP withdrawal. When you withdraw money from an RRSP, you must include that amount in your income for the year and pay taxes on it. For example, if you withdraw $10,000 from an RRSP and earn $15,000 from a part-time job/hobby, your total income for the year will be $25,000. As a result, you’ll need to pay ~30% of the $10,000 withdrawn from the RRSP in withholding taxes. The remainder can go into your TFSA.

When you withdraw money from your RRSP, the institution that manages your account will keep a portion of the withdrawal for taxes. Essentially, it’s our Canada Revenue Agency (CRA) getting their money back sooner than later. Depending on the amount you withdraw from your RRSP, you will have *withholding taxes:

• $5,000 or less, they’ll withhold 10%
• $5,001 to $15,000, they’ll withhold 20%
• More than $15,000, they’ll withhold 30%

Here is our Government of Canada source on that.

The amount withheld may not be the amount you owe when you file your taxes. It’s important to set aside some of the money for taxes in the future if you have a high income. (*Withholding rates are slightly different in Quebec.)

2. Remember that you can’t redeposit money back to the RRSP in the future

With your TFSA, any withdrawal you make can be deposited back into the TFSA in a future year. However, with an RRSP, if you withdraw money you’re not able to redeposit that money in the future.

How to move money from your RRSP to TFSA?

Easy but with some caution.

1. Request a withdrawal from your RRSP

You’ll need to have cash in your account to request a withdrawal. As a result, you may need to sell some of your investments ahead of time. You may be able to remain invested as you move money from your RRSP to your TFSA, however the process is more complicated and involves a non-registered account. We recommend you contact your RRSP provider to discuss your options before proceeding…

2. Pay your RRSP withholding taxes and potentially a small fee. 

As mentioned above, when you withdraw investments from your RRSP – withholding tax will apply. Your financial institution may also levy a charge called a “deregistration fee”, which could cost you $25 or $50 each time you move money out of your RRSP that is not coverted to a RRIF first.

3. Place investments in a non-registered account and/or transfer the shares from your non-registered account to your TFSA.

If you hold a stock or ETF units in your RRSP and you want to hold those in your TFSA instead, there is no way to simply transfer it from one account to the other – at least we don’t know of any brokerage that does this directly yet but let us know!

When it comes to cash, there is no direct way to transfer cash money in a Registered Retirement Savings Plan (RRSP) to a Tax-Free Savings Account (TFSA). In order to contribute funds to a TFSA from an RRSP, you must withdraw the funds, and pay any applicable withholding tax, plus any additional taxes at tax time. You must also have the available contribution room in your TFSA.

With assets from the RRSP to TFSA, essentially there is a “deregistration” of shares or units from your RRSP, that means you’ll be transferring them from the RRSP to a non-registered (taxable) account)), then once the shares or ETF units are in a non-registered account, you could then transfer them to your TFSA at your discretion. (Note that if assets appreciate slightly during the time it takes you to arrange all of this, you will pay tax again on any capital gain. If the shares fall in value, however, you will not be able to deduct any capital losses.)

Here is a source as per RBC:

https://www6.royalbank.com/en/di/hubs/investing-academy/chapter/tfsa-faqs/ki58km3e/ki58km3u

“Can I transfer assets in-kind to a TFSA from an RRSP without tax implications?”

“No. A TFSA and an RRSP differ in structure and you cannot transfer between them. If you wish to use assets (either cash or securities) from your RRSP to contribute to your TFSA, you must first withdraw the RRSP assets (subject to applicable withholding taxes), move the assets to a non-registered account, and then contribute to the TFSA. Speak to your tax advisor to make sure this is right for you.”

With such considerations in mind, we believe for many retirees should consider taking lump sums of cash out of the RRSP, using/spending what they need, then depositing that cash when new TFSA contribution room comes up each year. This will not trigger any additional tax consequences and of course, all growth moving forward inside the TFSA is tax-free.

When it comes to RRSP withdrawals, the idea is to “smooth out taxation” over time and avoid any lumpy tax hits in retirement when you can least afford major tax impacts with your portfolio.

Top Tax Tips for Retirees Summary

Beyond our list, there is of course spousal RRSPs (to split income between spouses during retirement) and also spousal loans to consider, but those are more nuanced subjects to discuss in detail for another day.

We believe if you can consider the following top tax tips for your retirement, you’ll be way ahead of most:

1. Keep assets in the right location.
2. Claim the tax credits available to you.
3. Split your pension income.
4. Convert your RRSP to a RRIF before age 71 (at least a portion).
5. Consider your retirement income drawdown order carefully.
6. Consider “smoothing out taxes” and moving RRSP/RRIF assets to your TFSA if you can.

Stay tuned for more, great, FREE content on our site. We’re happy to help.

Mark and Joe.

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